Cheap Money Chasing Risk Abroad

Easy money policies in the developed world promise further gains for emerging markets, writes Eoin Treacy of Fullermoney.

To compile a list of the winners and losers of 2010, I ranked 96 indices in terms of 12-month performance. I then redenominated the list to US dollars, euros, British pounds, and Australian dollars to demonstrate the impact currency movements have had over the last year.

The currency effect was particularly evident for euro-denominated assets, all of which suffered this year from the European currency’s decline. As a result this has been a particularly strong year for euro investors in the US, where the Standard and Poor’s 500 index rose 21.7% in euro terms. Germany, which has been one of the best-performing Eurozone indices, rose 16.1% in its local currency.

Such has been the strength of the Australian dollar that most indices have returned a negative performance when redenominated to that currency.

Mongolia, Bangladesh Beat Odds
Frontier markets in Asia such as Mongolia, Sri Lanka and Bangladesh were this year's best performers. Southeast Asian markets and commodity-led Latin American exchanges dominated in terms of performance. Technology-led markets such as the Nasdaq 100, Israel and Taiwan also performed well this year.

Of the 96 indices reviewed, 40 have made new six-month highs in the last five days. Commodity markets and Asian-led growth remain dominant themes, and while a number of Asian countries are now in inflation fighting mode most chart patterns, particularly in more developed Asia, appear able to support additional medium-term upside. Export-led European markets are also breaking out of yearlong ranges, and while somewhat overbought in the very short-term have potential to improve on their recent performance next year.

Carry Traders Carry On
2010 has been dominated by the divergence between the economic performance of the US, UK, and peripheral Eurozone on the one hand, and much of Asia and Latin America on the other. There is now also a clear divergence between the monetary accommodation offered by the US, UK, and Europe versus the tightening trend in much of Asia.

Accommodative monetary policy in much of the so-called developed world continues to provide abundant liquidity for those seeking a higher yield or outsized return in the global carry trade. The US dollar, euro, and British pound are all currently viable carry trade currencies because of their record low interest rates and the comparative weakness of their respective economies.

The excess liquidity produced to support these economies finds its way to other areas of the world offering a more attractive return. Brazil has been the most high-profile advocate of some form of capital controls, but other countries are also attempting to stem the tide of inward investment. However, this is unlikely to defuse the increased interest in higher-growth economies, and accommodative monetary conditions in much of the world are likely to remain a tailwind for risk assets in 2011.

Potential threats such as surging oil prices or significantly higher Treasury yields are both possibilities and will need to be monitored.